Brian Gaynor: Economic lessons from earthquake repairs

Construction work generated by the rebuilding of Christchurch's damaged areas is expected to provide a boost to the economy. Photo / Greg Bowker

It is extremely difficult to forecast the impact of the Christchurch earthquake on the New Zealand economy.

For example, the immediate reaction to the 8.8 magnitude earthquake in southwest Chile on February 27 this year was negative from an economic growth perspective but it is now having a positive impact on the country's growth rate.

The huge earthquake was centred in Offshore Maule, 335km southwest of the capital, Santiago.

At least 1.8 million people were affected with more than 500 killed and 12,000 injured. An estimated 370,000 homes, 4000 schools and 80 hospitals were either damaged or destroyed.

Electricity, telecommunications and water supplies were disrupted and the total damage was estimated to be between US$25 billion ($34.4 billion) and US$30 billion.

Before the earthquake the Central Bank of Chile was forecasting economic growth of between 4.5 per cent and 5.5 per cent for the December 2010 year.

Shortly after the quake the country's Deputy Finance Minister said GDP growth could be 1.5 percentage points lower than earlier forecasts and Goldman Sachs cut its December 2010 year prediction from 5.2 per cent to 4.4 per cent.

The Central Bank wrote in its March Monetary Policy Report "that the level of trend output will be between 1.0 per cent and 1.5 per cent lower than was considered before the catastrophe".

The Central Bank believed the earthquake would have a negative effect of about 3 percentage points and 2 percentage points on the March quarter and June quarter GDP growth figures respectively.

These predictions have proved to be far too pessimistic as the Chilean economy expanded by 6.5 per cent in the June quarter after a rise of 1.5 per cent in the March Quarter.

The strong second quarter was caused by a number of factors associated with the earthquake. These included a sharp increase in demand for durable goods (appliances and televisions), investment in machinery and equipment and an increase in construction activity.

The Central Bank of Chile is now forecasting GDP growth of between 5.0 per cent and 5.5 per cent for the current year, well above post-quake predictions.

The bank wrote in its September Monetary Policy Report that the higher GDP growth forecast was because the "swelling of consumption and investment decisions in the aftermath of February 27 exceeded projections".

The bank expects the Chilean economy to grow by between 5.5 per cent and 6.5 per cent next year although inflation is a concern.

Inflation is forecast to be 1.7 per cent and 3.3 per cent for this year and next respectively compared with earlier forecasts of 1.0 per cent and 2.7 per cent respectively.

However, most of the upward revisions are the result of higher cigarette prices, stamp duties and public transport fares in Santiago rather than a direct consequence of the earthquake.

Meanwhile, the New Zealand Treasury has released a short analysis entitled "Economic Impact of Christchurch Earthquake".

It notes: "It is too early to confidently assess the impact of the Canterbury earthquake on the New Zealand economy. This note provides some indicative estimates of the likely impact on overall GDP over the next couple of years."

There are a number of important differences and similarities between the Chilean and Christchurch earthquakes. These include:

* The Chilean quake registered 8.8 on the Richter magnitude scale whereas Christchurch was measured at 7.1.

* The damage in the former is estimated to be between US$25 billion and US$30 billion whereas the latter is around $4 billion (US$3.0 billion).

* The Chilean quake damage represents about 14 per cent of the country's GDP whereas Christchurch's damage is between 2.0 per cent and 2.5 per cent of New Zealand's GDP.

* Chile's population is 17.1 million whereas ours is 4.4 million.

* The area affected by Chile's disaster accounted for around 16 per cent of the country's GDP whereas the Canterbury quake area represented an estimated 15 per cent of New Zealand's GDP.

It looks as if the Christchurch reconstruction should have a much lesser impact on GDP than the Chilean quake but industry experts estimate that around 70 per cent of the Canterbury damage is covered by insurance, including the Earthquake Commission, compared with only 30 per cent in the Chilean catastrophe.

This higher coverage rate means the Canterbury region will receive a huge reconstruction boost even though total damages are much lower than in Chile.

The accompanying graph shows the Treasury's forecasts of the impact of the Canterbury quake on the country's GDP growth.

There is expected to be a negative impact in this quarter, followed by a positive 0.75 per cent in the December 2010 and March 2011 quarters. The June 2011 quarter will get the biggest boost - 0.9 per cent - with the positive economic impact fading after that.

On an annual basis the disaster is expected to boost GDP growth by 0.5 per cent in the 12 months ended June 2011 and by 0.3 per cent for the year ended June 2012. These forecasts may be on the light side.

These are, at best, educated estimates because we don't know how quickly Christchurch will be rebuilt or the impact of the disaster on the tourist sector.

The Chilean quake came at the end of the summer season whereas summer is just around the corner in the South Island.

We don't know whether potential visitors, particularly from overseas, will stay away or whether they will continue to visit the devastated area and help accelerate the recovery.

Although the Christchurch catastrophe has had a devastating impact on local residents it will divert resources into an area of the economy that is much more likely to take us out of the recent recession.

The economic argument, which is becoming increasingly popular in the United States, goes a bit like this.

The consumer, who accounts for around 70 per cent of economic growth, is shopped-out because of too much debt and the depressed state of the housing market. In other words economic recovery is not going to be consumer-led, there have to be other economic drivers.

Construction and infrastructure-led recoveries are obvious alternatives to a consumer-led recovery.

A number of influential US business people are promoting the strategy that governments in the United States, both federal and state, should sell infrastructure assets and use the proceeds to build new infrastructure projects or repay debt.

A similar approach needs to be looked at in New Zealand because the debt-loaded consumer is in no position to drive the economy out of recession through increased spending.

An obvious alternative is for the Crown to sell minority shareholdings in its commercial companies and use these proceeds to invest in the country's rundown infrastructure assets.

The new Auckland Super City could do the same by selling a stake in Ports of Auckland and a number of other assets and use the proceeds to invest in badly needed infrastructure assets, particularly roads and public transport.

Unfortunately, the domestic political environment is not sympathetic to that approach so it looks as if we have to rely on a natural disaster to create a construction/infrastructure led recovery.

The good news, from an economic point of view, is that the Christchurch quake reconstruction should boost economic growth through to next year's general election.

If the National Government is re-elected next year, and has the courage to sell minority stakes in its commercial assets, then the proceeds from these should be used to give the economy another construction/infrastructure boost.

It is patently clear that we are not going to have a consumption-led recovery and the preferred option is to have a government policy-led construction/infrastructure boost instead of just waiting for the next natural disaster.

Disclosure of interest; Brian Gaynor is an Executive Director of Milford Asset Management.bgaynor@milfordasset.com